What Is DeFi and How Does It Work?
DeFi rebuilds lending, trading and saving as open software. Here is what decentralized finance is, how it works, and what risks it carries.
Key takeaways
- At the heart of DeFi are smart contracts: programs that live on a blockchain and execute automatically when their conditions are met.
- DeFi makes services composable and open. Anyone with a wallet can lend assets to earn interest, swap one token for another on a decentralized exchange, or provide liquidity to a trading pool.
- Openness cuts both ways. Smart contracts can contain bugs, prices can be manipulated, and there is rarely a customer-support line if something goes wrong.
DeFi, short for decentralized finance, is a catch-all term for financial services — lending, borrowing, trading, saving — built on public blockchains and run by code instead of companies.
How it works
At the heart of DeFi are smart contracts: programs that live on a blockchain and execute automatically when their conditions are met. Instead of a bank approving a loan, a smart contract holds collateral and releases funds according to fixed rules anyone can read. Users interact directly from their own wallets, without opening an account.
What it enables
DeFi makes services composable and open. Anyone with a wallet can lend assets to earn interest, swap one token for another on a decentralized exchange, or provide liquidity to a trading pool. Because the building blocks are public, developers can stack them together like financial Lego.
The risks
Openness cuts both ways. Smart contracts can contain bugs, prices can be manipulated, and there is rarely a customer-support line if something goes wrong. DeFi removes intermediaries, but it also removes the safety nets they provide — users carry the responsibility themselves.
Editor covering blockchain, crypto and finance news. Based in Manila.
